8 December 2015Market Risk: Understanding and Managing Tail Events

Scenario 4: High Inflation World

Jaclyn YeoRisk Researcher

Centre for Risk Studies

Global Inflation Rates History

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High Inflation World

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Types of Inflation

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Coverage

Comprehensive (economy-wide)Sporadic

Period of Occurrence War-time Post-war Peace-time

Government control

Open Suppressed

Rate of inflation

Creeping (mild)

Chronic (secular)

Moderate Running Galloping Hyperinflation

Causes

Deficit Development Pricing Power Scarcity Demand-pull

(Excess demand)

Cost-push (Supply side)

Expectation

Anticipated Unanticipated

Inflation

How our Scenario plays out

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Key Transmission Mechanism

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Rising prices Inelastic goods

Cost-push Inflation

Global protectionism (monopolies)

Natural disasters

Essential commodities

(E.g. energy, food, water, electricity,

etc.)

Environmental collapse

Government regulation and

taxation

Exchange rate

Domestic Inflation

Import (price-hike) Inflation

Globalisation

Rising prices Inelastic goods

Cost-push Inflation

Global protectionism (monopolies)

Natural disasters

Essential commodities

(E.g. energy, food, water, electricity,

etc.)

Environmental collapse

Government regulation and

taxation

Exchange rate

Domestic Inflation

Import (price-hike) Inflation

Key Model Input Variables

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S/N Macroeconomics input variables

Scenario Variants Justification for shock Scenario-specific key assumptionsS1 S2 X1

1 Global Energy PricesMagnitude 210% 280% 440% 1973 Oil Embargo

Expansionary monetary policies (Keynesian principles adopted after WW2)

Oil production cut by up to 25%

Price of oil increased $3 to $12 per barrel, after the oil embargo

Global Oil Production

OPEC accounts for 40% global production

Growing risk of military dictatorship and oil production control

Duration 4 Qtrs

Key Model Input Variables

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S/N Macroeconomics input variables

Scenario Variants Justification for shock Scenario-specific key assumptionsS1 S2 X1

2 Global food pricesMagnitude 180% 250% 310% 2007-8 World Food

Crisis

World population increased from 6.6 to 6.7 billion

Developing countries food imports rose by 25% in 2007

On average the world price for rice increased by 217%, whilst wheat increased by 136%, maze by 125% and soybeans by 107% during this period

Global population trend

Population density explosion

Higher affluence

Changing weather patterns

Extreme natural disasters

Rising Oil Prices

Costs of fertilisers and food transportation

Bee colony disorders

71% of world crop species bee-pollinated

Up to 75% bee colonies in the US collapse during the 2006-07 period

Duration 4 Qtrs

High Inflation World

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Global Macroeconomic Impacts - Summary

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Macroeconomic losses S1 S2 X1

Global recession severity(Qtr GDP min. growth rate)

1.9% 1.4% 0.6%

Global recession duration No recession

GDP@Risk(5 year loss of global output)

$4.9 Tn(1.7%)

$8.0 Tn(2.2%)

$10.9 Tn(2.6%)

LocationMinimum GDP growth rate (% qtr)

Baseline S1 S2 X1China 5.3 2.7 1.4 -0.6Germany 1.0 0.5 0.1 -0.8Japan -1.2 -2 -2.5 -3.2United Kingdom 2.2 1.2 0.6 -0.7United States 2.7 0.6 -0.2 -1.6World 2.7 1.9 1.4 0.6

Global Macroeconomic Impacts - GDP@Risk

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Scenarios Baseline S1 S2 X1

Locations5-year GDP

GDP@Risk(US$, Tn)

GDP@Risk(%)

GDP@Risk(US$, Tn)

GDP@Risk(%)

GDP@Risk(US$, Tn)

GDP@Risk(%)

China 48.4 1.1 2.9% 2.0 3.9% 2.7 4.6%Germany 19.1 0.1 1.1% 0.2 1.5% 0.5 1.7%Japan 29.3 0.3 1.3% 0.4 1.8% 0.7 2.1%United Kingdom 14.0 0.2 1.5% 0.3 2.2% 0.4 2.7%United States 88.9 1.6 2.4% 2.5 3.1% 3.4 3.6%World 395.0 4.9 1.7% 8.0 2.2% 10.9 2.6%

However in Reality…

The world we live in today VS Counterfactual scenario narrative we described

So how will our results differ?

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Signals or Noise?

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2 Dec 2015

Reflections inour real world

Imagine… Short-term interest (Fed) rates now raised High inflation world sets in due to exogenous events

– What are the mitigation options by governments and central banks

Counter measures… Contractionary monetary policy

– Main goal of reducing money supply in the economy– Further increase interest rates

Another option is to increase the reserve requirements banks are legally required to keep to cover withdrawals– Reduces the money (supply) in circulation– Further adds credit stresses to the banking sector

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